Protection & Potential

It pays to protect the market downside on stockers but don't forget that the upside potential looks great, too.

Larry Stalcup | Apr 01, 2004

With the chance for higher corn prices and a market edgy over anything that resembles a public health scare, Harold Sides is one stocker operator not willing to let profit potential slip out the back gate. The Dawn, TX, diversified cattleman/farmer is using feeder-cattle futures and forward contracts as a strategy to protect the thinnest of expected profit margins projected for this summer and fall.

James Mintert, a Kansas State University economist, recommends cattlemen take a similar approach and not wade into uncharted marketing waters without a life preserver. Mintert advises the use of marketing programs that protect the floor against dreaded market zappers, but that also consider the potential for market rallies that also are likely.

“Given the heightened possibility another bovine spongiform encephalopathy [BSE] case could occur, cattle owners should protect their downside by selling futures or purchasing a put option,” he says. “However, given that we're approaching the cattle cycle's rebuilding stage, and the possibility the U.S. will reenter the beef export arena later this year, producers also should protect the upside.”

Looking To This Spring

Sides runs about 1,800 stockers/year, as well as about 135 English-cross cows. He also farms wheat and cotton.

At 350 to 500 lbs., stockers are placed on wheat pasture in late summer, supplemented in winter, then grazed out on wheat in the spring. Others go on a hay grazer or oats for late spring and summer grazing for marketing in early fall. All are usually sold as feeder cattle in the 750-lb. range to regional feedyards.

Sides already has forward contracting in mind for the calves he looks to buy in late spring, as well as feeder-cattle futures to secure a floor until a contract is established.

“We'll consider August feeder cattle futures in the $87 or higher range for cattle that will graze out into late summer,” Sides says. He says he puts as much emphasis on marketing as in putting on pounds and delivering a quality product.

“I once used options along with futures, but have since gotten away from them because the value of the options doesn't keep up with actual price of cattle,” he adds.

Nevertheless, Mintert says options could play a part in some marketing programs, considering the outside forces that could impact cattle prices this year and beyond.

“Cattle owners should have a double-edged strategy in place during 2004,” Mintert says. “If you sell futures as a short hedge, you should also give serious consideration to purchase of a call option.

“If prices rise in the period a producer owns the cattle, the call option's value also will rise, allowing the producer to benefit partially from the price rise,” Mintert says. “Meanwhile, you're protected on the downside.”

Sides sees slim profit margins for stockers on pasture for grazing this summer. Higher calf prices in the spring, plus the shrunken market, more than likely dictate it.

“You have to figure in margins that are very thin,” he says. “You have to bet on the come and hope for that market rally to establish the price you need to make a profit.”

BSE Protected

Sides sometimes alters his production and marketing plans. In some cases, like in 2003 when most of his cotton crop was hailed out, he replanted the failed ground with a forage for cattle to offset lost revenue from the ruined crop. He then looked for immediate methods to protect the cattle against a wreck. Forward contracts cushioned the blow from the BSE scare.

“We lost all our cotton last summer, so I came back with a BMR [brown mid-rib] grazer and put 350-lb. calves on it,” he says. “Prices were good then, so I decided to take out some price protection until I could establish a forward contract with a feedyard for March delivery.”

He sold March 2004 feeder-cattle futures in the $84-$86/cwt. range. Later in the summer, with prices even stronger, he contracted the cattle for $92. The hedges were lifted in late August, and he earned a small profit. He then watched the market climb past $95, and even approach $100.

When BSE hit, prices headed south in a hurry to below $85. As March approached, they stayed in that range, setting up a nice profit for his $92, 750-lb. English crosses.

“I know I left some money on the table by getting out of those hedges,” he says. “But I also locked in a good price and wasn't impacted by the BSE price drop. Those calves are making well more than $100/head and that's about all you can ask for in this business.”

Monitor Corn Prices

Even with another 10-billion-bu.-plus corn crop forecasted, grain prices climbed strongly earlier this year. December corn pushed past $2.90/bu. in early March. Continued increases in corn prices will probably force down feeder cattle prices.

“Feed prices are another wild-card concern for producers this year,” Mintert says. “The impact of $2.70 to $2.80/bu. corn prices has already been absorbed in the market. A crop shortfall this summer will substantially push up corn prices.”

“That same 10¢/bu. price rise pushes the breakeven on slaughter steers placed on feed at 750 lbs. up about 50¢ cwt.,” Mintert says. “All else being equal, cattle feeders will adjust down their bids on feeders to compensate for the higher feed costs. A cattle feeder would have to adjust downward the price paid for a 750-lb. steer by about 75¢/cwt. for every 10¢ increase in corn prices.”

Those types of situations may be avoided with a solid feeder-cattle hedge using futures, options or forward contracts.

“The ability to manage risk will be key to survival in the livestock business,” Mintert says. “Successful cattle producers will constantly manage their risk exposure and ensure they can withstand the risk they're exposed to at any particular point in time.”

Too Little Control?

With the large number of fund traders in livestock futures markets, some say producers and feeders have too little control in what determines futures prices, which virtually always determine cash prices. Sides is among them.

He and others are also concerned about permanent limit changes by the Chicago Mercantile Exchange in which feeder and live cattle contracts can trade. That limit was shifted from $1.50/cwt. to $3/cwt. During the BSE scare, it even expanded to $5/cwt. for a few days. Still, there's a need for a disaster protection plan to help operators stay in business.

“Given the heightened risk exposure faced by cattle owners today, I believe cattle owners should always have a disaster insurance policy in place,” Mintert says. “For most producers that means purchasing an out-of-the-money put that doesn't lock in a profit but does establish the producer's maximum risk exposure, or the maximum dollar loss on a particular set of cattle.

“Producers that had a disaster insurance policy in place on Dec. 23, 2003, (when the BSE find was announced) slept much easier than those who did not,” he adds.

Meanwhile, Sides recently enhanced his stocker operations and ability to obtain the highest price by purchasing an old feed truck to blend corn, silage and roughage to provide supplemental feed to his calves. “Too little rain means more supplement is needed,” says Sides, who handles the feeding himself. “With the added source of feed, I can maintain ½ head/acre of wheat pasture, and more for lighter weight calves.

“And the feedyards call us back for more cattle because these animals nearly all grade Choice and Select. That helps me establish a good contract price that I can usually live with,” he adds.

He stresses that diversification has become very important in his operation.

“I consider myself a tenant for the Lord,” says Sides, whose strong spiritual faith helps him through tough times. “We take advantage of what is offered from our land and our ability to get the most out of it.”